Public-Private Loans Help Tiny Businesses Get By

The Alameda Swap Meet in South Los Angeles is about the last place you’d expect to find a breakthrough in small-business lending.

Filled with Spanish-speaking mom-and-pop vendors selling cowboy boots, videos, quinceanera dresses and fresh fish, the indoor bazaar tends to be long on cash sales and short on formal bookkeeping.

But vendor David Manzo is building his business one swipe at a time. Every time a customer pays with a credit or debit card, a portion of that sale automatically goes to pay down a $5,775 loan to the Mexican immigrant, whose Mirna’s Market offers herbal remedies and religious items.

The loan’s 12 percent interest rate is a fraction of what Manzo paid in the past for expansion and inventory loans. And he never worries about repayment. If business slows down, his installments drop automatically; when things pick back up, the higher sales mean the loan balance goes down faster.

Keeping up with his payments “is just not a problem,” Manzo said, surrounded in his cramped stall by kidney pills, amulets, bath salts and devotional candles. “I really don’t have to think about it.”

In a season of political clashes over Uncle Sam’s role in the private sector, Manzo’s loan — an innovative product dubbed EasyPay — was made possible by a little-known partnership involving the government, financial institutions and charities.

His lender is Opportunity Fund, a nonprofit that is among roughly 700 federally certified Community Development Financial Institutions. The CDFIs, as they are known, include some small banks and credit unions, but most are community loan funds along with a scattering of venture capital funds.

The institutions provide subsidized loans to low-income and hard-to-serve customers using funds from banks, foundations, religious groups and individuals, along with awards from the U.S. Treasury.

Such microlending has boomed in the developing world, involving “lending circles” of individuals who pool their savings. There are also loans from institutions such as Grameen Bank of Bangladesh, whose founder, Muhammad Yunus, is a Nobel laureate.

Mainstream U.S. banks have found tiny loans expensive to administer and fear being criticized for charging rates high enough to cover their costs. So they have largely yielded the field to nontraditional private-sector lenders, including the CDFIs.

“Microlending can be the answer to job creation and upward mobility in the U.S. The problem is that financing a hair salon is a different ball of wax from financing a goat” in a developing country, said Mitch Jacobs, founder of On Deck Capital Inc., a for-profit microlender that makes short-term loans at 18 percent to 36 percent.

Jacobs said the biggest problem for banks is overhead costs, since determining a start-up’s creditworthiness is far more difficult than pulling a consumer’s credit score.

“Small commercial loans don’t make money for banks,” he said, “because rather than use the cheap personal FICO score, they have to gather business data, which is very hard to do with micro-businesses.”

By contrast, working intensely with tiny businesses is a primary focus of CDFIs, which have their roots in decades-old government efforts to reduce poverty. The CDFIs expanded their funding in the 1970s by reaching out to religious institutions, individuals and other private sources, but the biggest boost came from two early initiatives by the Clinton administration.

The Community Development Financial Institution Fund, a Treasury Department agency that certifies CDFIs and makes awards to them, was created in 1994. A year later, the federal Community Reinvestment Act was revised so that banks could automatically receive credit toward their obligation to lend in lower-income areas by providing funding to CDFIs. The banks typically lend money at 2 percent to 3 percent interest to the CDFIs, which use the cheap funds to make loans of their own.

Over the years, CDFIs have extended about $40 billion to tiny U.S. businesses, almost all of it coming from banks and private investors.

“We’re like tugboats — we can sort of prod capital into our communities,” said Mark Pinsky, chief executive of Opportunity Finance Network, an industry association and standard setter.

Traditionally affordable housing and small-business lenders, the CDFIs have proved much more adept than banks at serving certain niches.

Examples include loans to grocery stores in poor neighborhoods and the financing of building purchases for charter schools, said Megan Teare, a Wells Fargo & Co. senior vice president who manages the bank’s $400 million in CDFI lending.

Because CDFIs are closer to their customers and often less constrained by regulations than banks are, they’re often better positioned to stretch out repayment periods and to provide lower rates.

“It’s relationship banking on a very small scale,” said Bill Luecht, a spokesman for Treasury’s CDFI Fund, noting that the hand-holding often includes helping customers develop business strategies and improve their creditworthiness. “They may work with a business for a year or more before they even make a loan.”